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Ruling

Subject: Income Tax: Assessable income and deductible expenses - life insurance policy proceeds and premiums

Question 1

Are the proceeds received by the company in respect of the life insurance policies assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: No

Question 2

Are the premiums paid for the life insurance policies deductible expenses under section 8-1 of the ITAA 1997?

Answer: No

This ruling applies for the following period:

Year ended 31 July 2010

The scheme commences on:

06 June 2006

Relevant facts and circumstances

Background

The company was the owner and beneficiary of two life insurance policies.

The life insured by the policies was that of the Managing Director of the company.

The Board of Directors recognised that the Managing Director played an extremely critical role in managing the operations of the company and determined it was prudent to take out the life insurance policies to protect the capital base of the company in the event of the Managing Director's death.

In the 2010 financial year the Managing Director died and the company received payouts on both life insurance policies.

Policies

The policy details are as follows:

Policy Number 1:

Type of insurance - Life insurance for Managing Director

Policy owner - The company

Sum insured - $x,xxx

Commencement date - 2006

Expiry date - 2047

Policy Number 2:

Type of insurance - Life insurance for Managing Director

Policy owner - The company

Sum insured - $x,xxx

Commencement date - 2007

Expiry date - 2048

The total cover of these policies was $x,xxx

Purpose

The purpose of the insurance was to protect the company against any adverse impacts on its balance sheet resulting from the untimely death of the Managing Director. In particular, the policies were taken out to ensure that the company would have suitable funds to:

· Protect their capital structure

· Protect the goodwill they built with customers

· Repay any loans or debts that could be called in due to the death of the Managing Director

· Protect the strong credit rating they had with major suppliers.

Payouts

Prior to the Managing Director's death in 2010, the Insurance Company made an assessment that the Managing Director's terminal illness meant that the company met the terms and conditions for the policies to be paid.

The total payout from the policies was $x,xxx

Premiums

Premiums were paid by the company for each policy.

The premiums paid by the company in respect of the life insurance policies have been claimed as a tax deduction in prior years.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Question 1

Summary

The lump sum payments would not constitute ordinary income and therefore are not assessable under subsection 6-5(2) of the ITAA 1997.

Detailed reasoning

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Income Tax Ruling IT 155 (IT 155) provides guidance as to the assessability of premiums paid in respect of life insurance for key man insurance policies. The term "key man" insurance is used in the industry to denote insurance on the life of a director, partner, employer or other "key" person associated with the taxpayer in business. The types of policies involved are whole of life, endowment, term (or temporary) life assurance, sickness and accident insurance.

IT 155 provides that it has been the Commissioner's practice in relation to insurance policies taken out by employers in respect of their employees to treat the proceeds as non-assessable if a life policy is involved. Income Tax Ruling IT 2434 confirms the position that the proceeds of policies on the life of an employee are of a capital nature and do not form part of the assessable income of the recipient company.

The life insurance policies for the director were owned by the company and the premiums were paid by the company. The life insurance policies terms and conditions specifically state that the insurer will pay the policy owner a lump sum equal to the sum insured if the insured person dies prior to the expiry date of the policy or that they will pay a lump sum amount of 100% of the sum insured if the insured person is diagnosed with a terminal illness that is likely to result in death of the insured person within 12 months of the diagnosis regardless of any treatment that may be undertaken.

The insurance company accepted the taxpayers claim and paid the full benefit payment for each policy to the taxpayer as it was determined that the insured persons medical condition met the definition of terminal illness as per the terms and conditions of the policies.

The lump sum payment is not earned by the taxpayer as it does not directly relate to services performed. The payments would constitute one-off payments and thus do not have an element of recurrence or regularity. Although the payments can be said to be expected, and perhaps relied upon, this expectation arises from the investment in insurance, rather than from a relationship with personal services performed. Thus, the lump sum payments would constitute capital receipts.

Therefore, the lump sum payments would not constitute ordinary income and therefore are not assessable under subsection 6-5(2) of the ITAA 1997.

Question 2

Summary

The expenses relating to the premiums are not deductible under section 8-1 of the ITAA 1997 as the premiums are considered to be outgoings of a capital nature.

Detailed reasoning

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

Income Tax Ruling IT 155 provides guidance as to the assessability and deductibility of premiums paid in respect of key man life insurance. The term key man insurance is used in the industry to denote insurance on the life of a director, partner, employer or other key person associated with the taxpayer in business.

It has been the Commissioner's practice as stated in IT 155 in relation to insurance policies taken out by employers in respect of their employees to treat the premiums as non-deductible under section 8-1 of the ITAA 1997 if a life policy is involved. Life insurance premiums are considered to be outgoings of a capital nature.

In this case the life insurance policies were owned by the taxpayer. The insured person was a company director. The life insurance was payable if the insured person dies or becomes terminally ill. Therefore, IT 155 would apply to the taxpayer because insurance premium expenses are in relation to key man life insurance policies.

Based on the facts supplied, the expenses relating to the premiums are not deductible under section 8-1 of the ITAA 1997 as the premiums are considered to be outgoings of a capital nature.

As a result, amendments to prior year income tax returns of the company will need to be made as the company claimed deductions for the life insurance premiums they paid.